The Nobel Prize mix-up

I am delighted that the pioneer of microfinance, Mohammed Yunus of Grameen Bank, has won the Nobel Prize. Disclosure norms oblige me to report that I have co-promoted two microfinance institutions, Arohan in Calcutta and Sonata in Allahabad. So I am biased in Yunus’ favour.

But I am puzzled that he got the Nobel Prize for Peace. Microcredit is a great idea, but what does it have to do with world peace? Yunus says world peace is endangered by the rich-poor divide, and that improving the lot of the poor will improve peace.

Alas, the facts show otherwise. South Asia is wracked by violence and strife. But this is caused overwhelmingly by religious and ethnic friction, not poverty.

India faced a major insurrection for a decade in Punjab. This was its richest state. Militants were led by the richest class, Jat Sikhs.

Kashmir is India’s most egalitarian state with the lowest poverty rate—just 3.5 % in 1999-200, against the national average of almost 26 %. Yet over 50,000 people have been killed there since 1988.

Ethnic rivalry fuels violence in India’s north-east. Maoist insurrection is widespread in India’s poverty-ridden tribal belt, but this owes less to poverty than ethnicity.

In Sri Lanka, the rebellious Tamils have historically been richer than the Sinhalas. Osama bin Laden belongs to a millionaire Saudi family.

In Bangladesh, Yunus’ own country, Islamic terrorists in 2005 set off over 400 bombs simultaneously in 62 of the country’s 64 districts. Bangladesh has by far the most microcredit beneficiaries in the world. Alas, this has not brought peace.

So, is Yunus undeserving of a Nobel Prize? No. He should have got the Nobel Prize for Economics.

This has been awarded this year to Edmund Phelps for his work on the relationship between employment and inflation. His most important contribution was the concept of a natural rate of unemployment, technically called NAIRU (non-accelerating inflation rate of unemployment). He showed that in a market economy, some industries were constantly closing and other rising. So workers constantly need retraining for new skills and redeployment to new areas. This took time, and created temporary but inescapable unemployment. He called this the natural rate.

Earlier some economists theorised that labour shortages would cause inflation when unemployment fell to zero. Phelps showed that inflation would rise not when unemployment fell to zero, but when it fell below the natural rate.

This was an important theoretical insight. Yet in practice it has proved difficult to accurately calculate NAIRU, since underlying factors like productivity keep changing. America’s NAIRU was once estimated at 5.8%. That is, if unemployment fell below 5.8 %, inflation would accelerate. But thanks to rising productivity, US unemployment fell to 3.9% in 2000 without exacerbating inflation.

Inflation in rich countries is typically caused by rising wages. But in developing countries, drought and spendthrift governments are the main causes of inflation. So, NAIRU is not relevant to India, China and many others.

Phelps is a great economist, but his major insights have limited use in poor countries. The Nobel Prize committee has long been guilty of awarding prizes for abstract theories with limited application while ignoring innovations that have transformed countries.

Surely microcredit is a greater innovation than NAIRU. Before Yunus, economists and banks regarded poor people, especially poor women, as not creditworthy. The poor had no collateral or salary. The risk of default seemed very high. Women did not control household budgets. Banks found it exorbitantly expensive to service microloans.

Enter Yunus. He innovated the concept of lending to groups of poor women. If any member defaulted on a loan, her fellow members pressured her to pay up, since otherwise their right to borrow would disappear. This social pressure produced an astonishingly high 97 % rate of repayment, better than for industries.

Unlike earlier thinkers on poverty, Yunus did not ask for subsidies. To meet the high cost of servicing small loans he charged 20-24 % interest on loans. He proved that poor could afford this rate. Anybody repaying a loan qualified for a higher loan the next year. This proved an excellent incentive for repayment.

Today there are over 7,000 microfinance institutions across the globe, serving 16 million poor households with perhaps 100 million members. Not all borrowers have risen out of poverty: some barely manage to meet repayments. Yet the very availability of microcredit means that the poor do not have to sell their land and livestock in difficult times. Microfinance has greatly improved the status and power of women, who have become entrepreneurs even in conservative Muslim societies. In Andhra Pradesh federations of self-help groups have become grain traders, procuring over a million tonnes of maize. Women spend relatively more money on education and health, greatly benefiting children. Female empowerment has encouraged contraception and reduced fertility in Bangladesh.

In sum, microfinance dazzles both in concepts and practical application. For this, Yunus deserves the Nobel Prize for Economics.